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“Hall of Mirrors: Feedback Between Monetary Policy and Asset Prices” 02.21.20; Panel Remarks at the 2020 U.S. Monetary Policy Forum Sponsored by the Initiative on Global Markets at the University of Chicago Booth School of Business

Loretta Mester

Speech from Federal Reserve Bank of Cleveland

Abstract: Speaking about how monetary policymakers can gain insights from asset price movements, he pointed out that if policymakers are too concerned about meeting market expectations for fear of creating excess volatility, then this undermines the information content of asset prices. As he put it: “Such a strategy quickly degenerates into a hall of mirrors” in which the policymaker is at once sending signals to the market about future policy and trying to gain insights from the market. However, if the market’s expectations get too far out of alignment with those of the policymaker, the policymaker finds herself in a difficult situation. If financial markets expect easier policy than what the policymaker feels is appropriate and she chooses to accommodate the markets’ belief, this suboptimal policy could lead to macroeconomic instability in the future. If, instead, the policymaker chooses to disappoint the markets, she risks increased volatility and an unwanted tightening of financial conditions. The question is: how can policymakers best avoid the “expectations trap” (Chari, Christiano, Eichenbaum, 1998), and utilize the information content in asset prices?

Pages: 6
Date: 2020-02-21
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